I love reading about both science and investing, and this weekend these two hobbies intersected in a way that I feel could result in a profitable opportunity. Initially, my curiosity was piqued when I read about a possible method of extracting oil and natural gas through waterless fracking, by injecting carbon dioxide into the shale formations that hold these resources instead of the typical water and proppant mixture.
While the traditional method has been effectively used to drive a massive production boom in domestic oil and natural gas, questions remain about its safety and long-term viability, especially in arid regions without access to abundant water. The CO2 method reduces water usage and also has the added benefit of creating both a use and disposition method for this potentially harmful greenhouse gas. Once the gas has been injected into the rock formations, the wells can be sealed and most of it will remain underground, unable to contribute to global warming.
Shortly afterwards, I happened to read about a company that has already been employing a similar method for years. Barron's laid out the case that Denbury Resources (NYSE:DNR) was not only utilizing this enhanced oil production method, it was also trading at a very low valuation. This makes it not only the perfect way to play what I believe to be a long-term trend, but also an opportunity to get in early at a very reasonable price.
Denbury Resources has been under selling pressure since the end of last year, as many investors bailed out following the company's decision not to convert into an MLP (Master Limited Partnership) that could have paid out a higher dividend. The reason for this seemed well justified, as management felt converting either the midstream assets such as plants and pipelines that produce the CO2 or upstream oil-producing assets that funds them added unnecessary complexity that could potentially create conflicts of interest and undermine their competitive advantage.
These assets give them a strategic advantage but require long-term planning, so converting to an MLP might make them more difficult to manage. Since this infrastructure will allow them to more profitably exploit oil fields than other companies using traditional methods, it's no wonder management preferred to keep them close to the vest. The company's supplies of CO2 include both natural and man-made sources, from a deposit in the natural formation of Jackson Dome that the company continues to tap, to industrial sources like Air Products & Chemicals (NYSE:APD) and PotashCorp (NYSE:POT). Additional future sources range from Mississippi Power's soon to be completed power plant to one of Exxon Mobil's (NYSE:XOM) natural gas processing plants, demonstrating the potential demand for disposal of CO2 gathered by carbon capture technologies.
Instead of giving in to the market's wish for them to become an MLP, the company introduced a number of other tactics to create value for shareholders. The first was the initiation of a quarterly dividend of $0.0625 per share, or 25 cents annually. While the resultant yield of just over 1.5% pales in comparison to what the higher payout ratio an MLP likely would have provided, it gives them the flexibility to maintain capital spending as well as raise the dividend over time, with annual payouts of 50 to 60 cents expected by 2015.
The announcement also increased the company's share repurchase authorization by a quarter of a billion dollars, something that was again repeated earlier this year. Clearly, the company feels their shares are undervalued and that a stock buyback offers exceptional value to shareholders, as they have already bought back nearly three quarters of a billion dollars worth of stock, or over 12% of the outstanding shares since the company initiated the buyback program in 2011.
It's easy to see why with the stock trading at such low price to earnings ratios of under 14 and 13 based on trailing and forward P/E ratios, respectively. Even more relevant, the company has been buying back shares well below its estimation of the value of their assets, never paying more than 75% of their estimated present value. Furthermore, operating cash flow of well over a billion dollars will allow the company to pursue these shareholder friendly activities while still funding growth in production and reserves.
The company's unique CO2 distribution network and advanced oil extraction method allows them to exploit their existing fields for longer and also target projects that would be unprofitable using traditional methods. This means they can acquire resources for bargain prices and maximize value by keeping them producing for not only longer, but also at lower production costs of about $25 per barrel of oil.
Using this method that they have honed over the years will allow them to continue targeting increased oil production, as well as potentially applying their expertise to the burgeoning field of waterless fracking to extract natural gas as well as oil. The company's vast distribution network, CO2 supply, and existing relationship with suppliers gives them a leg up on any potential competitors that might look to enter this promising area.
Buying Denbury Resources looks like a good way to capitalize on both the value the company is currently creating through existing operations and shareholder-friendly actions like opportunistic buybacks, as well as possibly enjoying additional upside provided by the increased dividends funded by exciting long-term growth opportunities.
Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in DNR over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.